Selling a Company: Putting a Value on Stock (Inventory)

A large part of the cash tied up in the balance sheet of any manufacturing or trading business is in the form of stock (inventory). Buyers of private companies will seek contractual protections that make sure they only pay for stock that is in a saleable condition.

I spent a fair chunk of Friday in a meeting with the preferred buyers of a food manufacturing client squabbling (yes squabbling is the right word) about “good” stock, or in American parlance inventory, and “bad” stock. Agreeing the value and quantity of stock that will be bought as part of the consideration is a bone of contention in every company sale, but in particular private company sales.

Why Is The Value Of Stock Such An Important Issue When Selling A Company?

As every company owner knows as the business grows a substantial proportion of after tax profit goes towards funding stock. The value of the stock is a big part of the wealth the owners have invested in the business, and they will be determined to extract this value as part of the sale. Let’s cut to the chase here. At the start of every business sale process without fail the owner tells me there is no obsolete or slow moving stock in his balance sheet. Without fail a minimum of 5% and more often 10% of dubious stock is found by the buyer’s accountants during due diligence. Buyers know this, and stock will always be an important issue when negotiating the sale contract.

Let’s look at this from the buyer’s perspective for a minute. Would any sensible businessman buy stock from a supplier that is unfit for sale, or at current rate of sale will probably sit around for a year or more, and then be written off? Off course not. Why then would a company buyer agree to pay for stock in this condition?

What Are The Main Contractual Protections Demanded By Buyers?

Once the seller has faced the inevitably of a negotiation about the definition of “good” stock most negotiations centre around the same issues:

Counting and valuing stock

Agreeing a mechanism for the parties to count the stock together and put a value on it (usually delivered cost from the supplier but sometimes market value for commodities).

Definitions of saleable, unsalable and slow moving stock

The parties need to agree definitions of “unusable or unsalable” stock that are relevant to the industry in which they operate. What will happen to stock that is not bought or used, and which party will pay the costs of disposal are other areas of negotiation.

Agreeing a definition of “slow moving” stock, and how much of it will be bought at closing, is always contentious. The physical disposition of the stock often has to be agreed. Will it be stored by the buyer and paid for if used or sold? Will the seller have the right to sell off the stock at distress prices if not wanted by the buyer?

Buyer pays for stock as it is used

Since the start of the credit squeeze we have seen a number of transactions where the buyer pays for stock as it is used, instead of paying for it in full at completion. For this type of arrangement I always try to negotiate a clause that seller’s stock will be deemed to be used before any new purchases of stock.

Right to audit

It is also essential that the seller has access to stock records, and a right to audit, after the sale to make sure the buyer is following the negotiated agreement.

If you are interested in finding out more about these and other issues relating to the sale of a private company one of our business sale experts would be delighted to talk to you in complete confidentiality. Click CONTACT ME to book an initial phone conversation or call us on 01604 432964.

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